Don't double discount

Want two ways of arriving at a higher valuation of your private equity portfolio? No? Well please indulge us anyway. The latest draft guidelines from the International Private Equity Valuation (IPEV) board, published towards the end of May, offer two pieces of advice that may have the effect of increasing valuations compared with established practice and previous advice.

How to increase portfolio value part 1: when estimating the enterprise value of portfolio companies, many fund investors have traditionally taken into account the lack of marketability of a private company (the so-called marketability discount) as part of the calculation – and have then added a separate marketability discount on top (known as “double counting”). IPEV advises that the discount should only be taken into consideration when estimating the enterprise value and that there is no need for an additional discount.

“This could lead to changes on how portfolio companies are valued,” says Mathias Schumacher, managing director in the London office of financial advisory firm Duff & Phelps. “Depending on how private equity firms have arrived at their fair value conclusion in the past, I would expect that for some the new guidelines will lead to an increase in fair value as the marketability discount has been considered twice.”

How to increase portfolio value part 2: recent Financial Accounting Standards Board advice had appeared to recommend secondary market transactions as a useful guide in estimating the fair value of a fund interest (albeit with various disclaimers). IPEV says the reported net asset value of the fund can be used to estimate the fair value of an LP interest (as a proportion of the reported NAV) as long as the assessment of NAV results from a “robust” process. Secondary transactions are considered to be of limited value by IPEV because of the opaque nature of the secondary market.

In the interests of balance, it would be remiss of us not to note one piece of IPEV guidance that could have the opposite effect of depressing valuations. Namely: the removal of a “safe harbour” period (typically a year) in which cost is assumed to reflect fair value. IPEV rejects this safe harbour period and emphasises the need for the proper assessment of fair value at every reporting date.

IPEV was launched in March 2005 by the French, British and European venture capital associations “to reflect the need for greater comparability [of valuations] across the industry and for consistency with IFRS and US GAAP accounting principles”.